The psychology of M&A deals: four mindsets to avoid

The unfortunate outcomes of many merger and acquisition projects are well-documented.

Across many studies, there is broad consensus on why so many deals fail: flawed strategy, inflated valuations and bungled integrations top the list.

Large scale mergers and acquisitions (M&A) are particularly prone to disappointing outcomes, especially from the perspective of shareholders. Yet, despite mounting evidence that a deal may destroy value, executives often press ahead.

This is not about misfortune or bad luck. It is about decision-making.

The price might escalate due to competitive bids, due diligence may uncover significant risks, and it may become increasingly apparent that integration will be more difficult than originally thought, and less likely to deliver the planned benefits. Still the buyer proceeds.

The option to walk away remains until the ink dries, but few CEOs take it. Despite the accumulation of unplanned events reducing the return – often to the point that the deal no longer makes sense – the transaction goes ahead. CEOs are reluctant to pull bad deals.

So why is that? In order to find out, I’ve looked at four different mindsets which influence CEO thinking.

1 Leaving a legacy

Firstly, with more significant deals there is often the issue of leaders wanting to leave a legacy.

This is all about committing to a major transformative purchase which changes the business markedly. It is a dangerous notion and often results in leaving a huge burden which successors have to manage.

Remedies may include selling off the acquisition, usually at a substantial loss. We saw this with US telecoms infrastructure provider AT&T acquiring the content producer Time Warner for $106 billion in 2018 after selling the masts business to fund it.

The deal was a disaster, halving the AT&T share price, which only recovered when they subsequently sold it off.

The minute I hear the word ‘legacy’ I start to worry about the likely outcome. This mindset turns the business benefits of any project into a personal crusade designed to leave a lasting memory.

Instead it usually leaves a major white elephant for the next management team.

2 Deal focus

Deal focus involves making a decision at a very early stage to acquire a target irrespective of the cost and risk, which are viewed as almost irrelevant.

The leader is so keen to do the deal that they ignore any contradictory information and only see supportive data and views.

Anyone internally opposing the deal is seen as a ‘blocker’ or ‘negative’ rather than offering objective insight.

Other managers and advisers soon realise that their role is to support the deal which leads to a ‘groupthink’ approach. As a matter of fact, this intolerance of any negative findings can continue for years after the deal is completed, despite obvious signs of failure.

CEOs often don’t like dissent, whatever the circumstances, which stifles any open or objective debate. Most decisions improve with challenge but some company cultures make this almost impossible.

This might be to the point that the option of not buying a target can’t be openly discussed.

Actually, the finance team may feel they are expected to project synergistic benefits to justify the deal.

No wonder integration teams fail to deliver the benefits originally forecasted. They usually had little or no say in determining what can and cannot be achieved.

3 The heat of the deal

Getting a deal ‘over the line’ is no mean feat. M&A transactions often stretch over many months, absorbing vast amounts of time, energy and capital.

For the teams involved, the transaction becomes all-consuming – often their sole professional focus. The sunk cost of this effort, both financial and emotional, begins to weigh heavily on the decision-makers.

Can one really walk away after investing so much?  

Compounding the issue is the incremental nature of bad news. Risks and complications rarely arrive all at once. Instead, they accumulate gradually. Each one on their own does not merit terminating the deal, but taken together they become a problem.

Added to this is the concern that if you don’t buy the target then a competitor may swoop in, reshaping the market to their advantage. This may be the one-and-only chance ever to acquire the target. If that is missed then the opportunity is unlikely to arise again.

All roads lead to Rome, despite this now being a bad acquisition, yet we still do it. ‘Buying to own forever’ is the mantra which starts to overshadow any commercial sense. To objective bystanders, the deal may no longer stack up, but internally, the momentum is unstoppable.

It is a fine line between having the determination and focus to push a transaction through the many complexities and obstacles which arise over a long period of time, and ignoring the warning signs.

At what point do you change course? Many decision-makers don’t, despite a deal becoming bad.

4 Denial

In a recent survey, 64 per cent of CEOs were said to be happy with their acquisitions. Could it be denial of the outcomes or lack of knowledge?

Businesses rarely admit mistakes, or not unless they are forced to. Internally they may not know or ask about the outcome of an acquisition.

To enable corporate learning, a review of acquisitions after one, two or three years is sensible to identify lessons to be learned. However, some corporates simply do not do this, or they reserve the process for smaller acquisitions on the grounds that larger ones are a matter of strategy.

Strategy is sometimes taken as a carte blanche to destroy value in pursuit of a greater vision. The strategy is expected to triumph in the end.

Such thinking neatly sidesteps any accountability on the grounds that the strategy will win out one day. Yet the evidence is often very different with major acquisitions destroying shareholder value for the next 10, 15 or 20 years.

Of the largest 10 transactions ever done the only ones which have avoided major long-term value destruction are those in which the destructive acquisition was then sold off. In the remainder, shareholders are still regretting the deal.

Announcements will always remain positive about an acquisition to the point that it is blindingly obvious that there are problems.

Indeed, one advantage with smaller deals is that the outcome is rarely apparent externally, whether good or bad.

Buy, improve, sell

Mergers and acquisitions cause much excitement, passion and emotion, but these are the very factors that are likely to lead to less-than-optimal outcomes.

Rather, objectivity should be the name of the game – an approach more typical of private equity (PE) firms.

PE firms have few fans, other than their investors, who generally do well. But in their favour is the buy-improve-sell model they employ, which requires much discipline and objectivity to hit their target returns.

The PE approach is to build a detailed model of the various factors such as price, cash flows and benefits from improvement work. If the model does not produce a return in excess of their threshold target then PE firms will pull out and walk away. They generally avoid chasing prices higher or over-estimating benefits to justify a higher price.

Having worked with PE, I have generally found that financial estimates of improvements are often halved for input to the model in order to reflect the practical difficulty of implementing savings and increasing sales.

PE funds are naturally conservative in their approach as a bad outcome is highly visible and raising future funds from investors will then be difficult.

It is when PE firms depart from their usual approach of objectivity – punctuated by an innate conservatism and careful assessment of the risks – that they begin to make mistakes.

Ultimately, M&A is not for the enthusiast. It is for the objective.

Further reading:

Mergers and acquisitions: four steps to deliver value

Four rules to avoid failure in mergers and acquisitions

Six tips to find hidden benefits in tech M&A

Deliveroo investors are paying the price amid takeover

John Colley is Professor of Practice in Strategy and International Business at Warwick Business School and author of The Unwritten Rules of M&A: Mergers and Acquisitions that Deliver Growth - Learning from Private Equity.

He teaches Mergers and Acquisitions on the Executive MBA and Executive MBA (London), the Global Online MBA and Global Online MBA (London), the Accelerator MBA and the Full-time MBA. 

Learn how to add value and avoid common pitfalls in M&A with the three-day programme, Mergers and Acquisitions: How to Maximise Success, at WBS London at The Shard.

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